T3s are
only the beginning
Now that
the RRSP frenzy is behind us, most of the T3 and T5 slips from GICs, stocks,
mutual funds, segregated funds, and other pooled investment products should
have trickled in by now. (Actually, the deadline is the end of March for those
slips.) However, for investors gathering their tax information, that’s just the
beginning. For investors with mutual funds or other investments in taxable
accounts, we must look beyond the standard tax slips to determine the ultimate
tax bill or refund. Here are a few tips to make sure you get it all straight.
The
dreaded adjusted cost base (ACB)
Whenever you sell units of a fund, or shares of a stock,
there is some tax consequence – usually a gain or a loss. To figure out any
gain or loss, the ACB must first be calculated. ACB is the same as book value, which is the
average cost of an investment and is usually expressed per unit or share of the
investment in question. Very basically, ACB per unit is calculated by taking
the total of all purchases (including any buying commissions), and dividing
that sum by the total units or shares purchased. Use units or shares purchased.
Technically ACB per unit is calculated as:
(total
purchases + acquisition costs + reinvested distributions) ÷ (units purchased)
Only units
“purchased” should be used here, not unit “balance”. Why? ACB is the average
acquisition cost, so only purchases impact your per unit ACB. Let’s look at an
example.
Suppose you
make the following transactions in a mutual fund:
·
BUY 117.6471
units @ $8.50 per unit for a total purchase price of $1,000
·
BUY 210.5263 units @ $9.50 per unit for a total
purchase price of $2,000
·
SELL 150.0000 units @ $10.00 per unit for total
proceeds of $1,500
Total
purchases are $3,000 ($2,000 + $1,000), which bought a total of 328.1734
(117.6471 + 210.5263). From there, we calculate the ACB per unit as $9.14
($3,000 ÷ 328.1734). The capital gain or loss is then calculated as:
(selling
price per unit – selling costs – ACB per unit) x (number of units sold)
Selling
costs can be any costs incurred to sell your investments, such as brokerage
fees, redemption charges, or any other transaction related fee. In our example,
the capital gain is $129 ( [10.00 – 0.00 – 9.14] x 150 ). If the next
transaction in that series is another “sell” transaction, the ACB per unit will
still be $9.14. It can’t be stressed enough that the $9.14 will only change
when additional purchases are made. For 2001 and subsequent years, only half of
capital gains will be taxable. However, for the 2000 tax year, I won’t even
begin to try to explain the taxable amount (i.e. inclusion rate). Two federal
budgets resulted in three different inclusion rates, so pay a visit to this
site’s Tax Centre where you’ll find a summary of the tax changes
(http://www2.mybc.com/money/tax/2000_changes.html) for the 2000 tax year. Those
are the basics, but there are a couple of other points to mention depending on
the specific investments you hold.
Mutual fund
investors who receive distributions in cash – i.e. not reinvested – should not
include such cash distributions in the above calculation. Only reinvested
distributions are added. Further, there are some mutual funds that pay out distribution
that are greater than the actual income generated in the fund. The result: the fund dips into the original capital to
pay out the distribution. When a fund does this, that part of the capital paid
out is called a “return of capital”. Since it’s a return of capital, it isn’t
taxable. There are two things to know about return of capital distributions.
If you
receive any “return of capital” distributions and it’s not reinvested, your ACB
per unit for that fund is reduced by the amount of “return of capital” per
unit. How do you know if you’ve received a return of capital? Look at your T3
and annual mutual fund statement side-by-side. If the total of “distributions”
listed on your statement for the year exceeds the amount of income shown on
your T3, you’ve got a return of capital. If, on the other hand, this return of
capital distribution is reinvested, the net effect is nil. In other words, the
fact that a fund returns original capital reduces the ACB, but the fact that
it’s reinvested bumps it back up. Check this out for any fund with fixed
distributions. Funds notorious for paying out capital include Mackenzie’s
Industrial Income, Mackenzie Industrial Dividend Growth, and Clarington
Canadian Income.
The tax implications of segregated funds are pretty much the same as for mutual funds with one primary difference. When a mutual fund manager was unsuccessful in her stock trading and realizes a net capital loss for the year, the loss cannot be passed on to investors - only gains are flowed through to investors. The loss is kept in the fund to offset any future gains from the fund’s stock selling. However, segregated funds do flow losses through to investors. That allows you to claim that loss immediately against any other gains you may have, rather than waiting for the fund manager to generate future gains. Further, when calculating your ACB of a segregated fund, the capital loss that is flowed through to you also reduces your ACB.
Labour sponsored investment funds (LSIFs)
This year,
many LSIFs became eligible for redemption without the tax credit clawback. If
this was done in a taxable account, there are special rules of which to be
aware. Any tax credits received by an investor on the original purchase of the
LSIF has no effect on the ACB. However, if you sold your LSIF units at a loss,
the original tax credits will reduce your capital loss.
Exempt
gains balance (EGB)
Did you crystallize gains for the general capital gains exemption on your 1994 tax return? Do you still hold units of funds for which you crystallized gains? If so, make sure you don’t forget to benefit from this time-limited tax shelter. When gains were crystallized for mutual, segregated, or any type of pooled investment fund (known as flow-through entities), the ACB of these units didn’t get bumped up like they did for stocks. Rather, a “pool” of exempt capital gains was created for each fund for which gains were crystallized. You could use a fund’s exempt gains balance to offset only capital gains (either from distributions or from selling units) of that same fund. But investors were given only ten years during which to use up that pool, which means you must “use it or lose it” by the year 2004.
Hopefully,
these tips will better help you prepare your taxes or at least help you get
more organized when you deliver your pile of papers to your tax preparer. It’s
also worth noting that although I’ve tried to highlight the important points on
mutual fund taxation (and ensure their accuracy), there may be things I’ve
overlooked that apply to some of you. Hence, it’s always a good idea to seek
the advice of a real professional when it comes to taxation.
Dan Hallett, B.Comm.,
CFP is Senior Investment Analyst with Sterling Mutuals Inc. He can be reached
at dhallett@sterlingmutuals.com. Sterling Mutuals is registered as a mutual
fund dealer in Ontario, British Columbia, and Manitoba.